Vinod Khosla on Corn Ethanol: Time to Move On

We are approaching the expiration of tax subsidies for corn ethanol. Established in 2004, the initial purpose of the subsidy was to help nurture a nascent biofuels industry, help reduce America’s oil dependence, and serve as a stepping stone to cellulosic biofuels. However, the time has now come for us to stop subsidizing corn ethanol and let it compete as a fuel on its own economic and environmental merits.

Why should the corn ethanol subsidy expire? From a technological and economic standpoint, corn ethanol production has little potential upside left in process cost reduction; public interest subsidies should be used to introduce new competition to markets or support new technologies to get down the early cost curve, not to support mature technologies.

Additionally, the subsidies that are in place have enabled some very large businesses to collect hundreds of millions of dollars per year of taxpayer cash without truly fostering, with rare exceptions, new technology development from non-food crops that can scale enough to help wean America off of foreign oil. Corn ethanol has become a dead-end street with little public benefit. The same money could be more effectively spent on emerging cellulosic, non-food biofuel technologies that are in fact being suppressed by corn ethanol’s maturity and subsidies for both the corn and the ethanol.

I have always argued that subsidies should be a short-term, and not a permanent measure, used for five to seven years after a technology first starts scaling in order to allow it to transition down the cost curve until it can compete on its own merits. Today the CBO notes that of the 11 billion gallons of biofuels sold in the U.S., 10.8 billion are corn ethanol[1]; at this point, it can no longer be argued that corn ethanol is a small new industry, in need of developmental aid to help bridge the commercial funding gap. Furthermore, corn ethanol today has minor innovation or cost reduction potential. From an environmental perspective, the picture is not much better; the same CBO report noted that the greenhouse gas benefits from corn ethanol (in the U.S.) come at a cost of $750 per metric ton of CO2e -- a mindboggling amount that is not scalable.

There are plenty of nascent biofuel technologies that are prime candidates to become economically and environmentally viable fuels but still have technical risk, and have very little scale. Still, they are far enough along to be reasonably low-risk candidates to help us meet our oil dependence goals in the next few years.

So when should one use subsidies? I believe they are valuable whenever there are new technologies that have a clear societal benefit, have a path to being market-competitive, but aren’t advanced enough or don’t have the scale to deploy the technology competitively versus alternatives. For each industry, there is an incentive structure that will maximize new technology innovation and scale-up speed, while assuring a good return for the money spent. A potential structure is to start ramping down direct subsidies when a class of technologies reaches a few percent of the existing market, though defining a market can be tricky.

Should solar and wind be lumped together when they started at such different times and scales? It is probably time to reduce subsidies for wind, but solar is still on a rapidly improving cost and new technology innovation curve. In the future, it will be a judgment call by the regulator to determine if these and other next-generation technologies merit their own “technology class” designation and a new round of subsidies or mandates, while letting the older ones expire. The resources spent subsidizing wind could well be spent on subsidizing electrical storage for wind, which would substantially expand the market and quality of wind power. Mandates are valuable when they create new (hopefully short- to medium-term) protected markets where new competitors to existing fossil technologies can incubate and grow, adding optionality to society. Subsidies help the new technologies get down the cost curve and can help if entrenched competitors are blocking a new technology. As a technology matures, costs stop declining and sufficient scale is established; at that juncture, the new baby should learn to walk and live on its own without support.

The question arises: in areas with existing subsidies, what to do with newly developed technologies that are in effect latecomers to the party? I believe that tax credits or cash grants to support promising R&D covering the areas of interest are more effective in encouraging innovation than are project subsidies. And they help nascent technologies that are not yet in the market. Top-down mandates (e.g., the renewable fuel standard) help create markets, creating incentives for new venture funding of promising but unproven technologies that may one day grow up to increase competition in large fossil markets.

One look at the Khosla Ventures biofuels portfolio shows that diversity of technologies is on our agenda. HCL turns biomass such as wood chips into sugars. Kior goes straight from wood chips to crude oil. Coskata, Lanza and Range use gasifier technology to feed a bio-fermentation process for syngas or carbon monoxide to ethanol and other chemicals. Meanwhile, HCL sugars (or sugar cane) can be used to feed processes at Gevo, LS9 and Amyris, which produce, respectively, isobutanol, diesel and farnesene. All of them are reaching a stage where they are starting to build (or retrofit) commercial-scale plants to produce their particular chemistry at market-competitive prices between $60 and $120 per barrel of oil. Surely these costs will decline as they build multiple plants and gain more experience. In 2010 it appears that we are likely to have a higher success rate than I would have forecast even three years ago, though some of our efforts can still fail.

What is clear is that as we emerge from the multi-year plant construction process, more than one -- and maybe even up to a half-dozen of them -- will become cost competitive with oil at its current price range, unsubsidized! The reality is that they and other innovative efforts will be hindered, not helped, by continuing corn ethanol subsides.

Meanwhile, the scalability (and hence the energy security benefit) of the subsidy is constrained by the limits on corn as a feedstock, the controversy around food-based fuels, and the Renewable Fuel Standard (RFS) already in place, which is the primary driver of ethanol demand. Subsidy or not, the market for corn ethanol will still be mandated for the foreseeable future.

As the NRDC notes, the net result of VEETC [Volumetric Ethanol Excise Tax Credit] is that we are “paying oil companies billions to buy corn ethanol they are already required to purchase under the RFS.” It’s not doing much for employment, either -- an Iowa State report estimates that allowing the VEETC to expire would result in the loss of approximately 400 jobs; preserving it means an estimated annual cost of $15M a year for each direct job.

At a high level, corn ethanol subsidies are essentially a giveaway to a few large players -- for example, it is estimated that BP alone receives $600M in tax credits[2] of the $6B in subsidies that are distributed. To quote the NRDC again, “a mature, mainstream technology with dubious environmental performance gets four times the credits available to companies trying to expand all other forms of renewable energy, including solar, wind and geothermal.” At a broader level, the tragedy is that corn ethanol has lead to a general perception in the media that all biofuels are the same, and has soured the nation on all biofuels to the point where we are ready to throw the baby (cellulosic next-gen fuels) out with the bath water.

Corn ethanol has helped in the development of the biofuels infrastructure and by serving as a stepping stone for the next-generation of biofuel technologies. But all subsidies should come with expiry dates, be they with corn ethanol, cellulosic biofuels, electric cars. With respect to fuels, for the next few years, I believe subsidies should be directed towards non-food based cellulosic biofuels, with a variety of technologies (and fuels) that have the potential to scale at economic cost to meet our liquid fuels dependence while making meaningful reductions in our carbon footprint. As mentioned earlier, we have a multitude of efforts across various fuels and may be perceived as conflicted[3]. But our portfolio is simply one of many and if we agree on the reasons to subsidize technologies, my arguments still hold. In the long run, biofuels can make a major dent in our oil and compete unsubsidized with fossil crude oil. Support for these new technologies should also have an expiry date before 2020.

[3] 1)KiOR, which is producing a “bio-crude” that can be a drop-in in today’s refinery infrastructure 2) Amyris (which recently IPO’d) and LS9, both of which have different technology platforms towards producing a cellulosic diesel and specialty chemicals 3) Gevo, which is retrofitting corn ethanol plants to produce biobutanol and specialty chemicals 4) Coskata and Range, producing ethanol from wood chips 5) Lanza, using waste industrial flue gases to produce liquid biofuels

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Khosla Ventures offers venture assistance, strategic advice and capital to entrepreneurs. The firm helps entrepreneurs extend the potential of their ideas in breakthrough scientific work in clean technology areas such as solar, battery, high-efficiency engines, lighting, greener materials like cement, glass and bio-refineries for energy and bioplastics, and other environmentally friendly technologies, as well as traditional venture areas like the Internet, computing, mobile and silicon technology arenas. Vinod Khosla founded the firm in 2004 and was formerly a General Partner at Kleiner Perkins and founder of Sun Microsystems. Khosla Ventures is based in Menlo Park, California.